Foreign Currency Trading

By : Stephen Bigalow
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Foreign Currency Trading - Understanding The Rates

To many people, it all seems like a tangled bowl of spaghetti; how can one currency trading chart reads that the index for the US dollar is 1.68, the Euro is 1.90, and the Canadian dollar is .73? Understanding the exchange rates for foreign currency trading isn't difficult but it can be a little confusing. By understanding the language of the Forex markets it is easier to understand these rates and untangle the spaghetti.

Basic Foreign Currency Trading Rates

The exchange rates for foreign currency trading are really born out of a simple formula. That formula reads like this: Y-to-X exchange rate = 1 / X-to-Y exchange rate. Because of this inversion, comparing US dollars to Euros is a different number than comparing Euros to US dollars. For example, one Euro is worth 1.34 US dollars but 1 US dollar is worth .75 Euros. Since a Forex trade is bi-directional, so are the ratios.

If it still doesn't seem to make sense, think of foreign currency trading the same way you would if you were converting from metric to English measurement and visa versa. One mile is equal to 1.6 kilometers , yet 1 kilometer is only equal to 0.6 miles .

How to Read Foreign Currency Trading Charts

Forex markets use charts that have a basic structure for foreign currency trading; the first column is the country code, which is a three letter code that designates the currency. For example, the United States dollar is represented by USD, while the Canadian dollar has a code of CAD. The second column in a foreign currency trading chart is the name of the country and its currency. The remaining columns each reflects comparisons between the base currency desired and other currencies. This type of foreign currency trading chart allows for fundamental analysis of the rates for a particular currency against the other currencies of the world.

This example helps to show the workings of the chart and the relationship between the various currencies. For instance, looking at the row for the Canadian dollar, the foreign currency trading chart shows that the US dollar is worth about 1.37 Canadian dollars, one CAD is worth about .73 USD, and just for assurance 1 CAD is equal to 1 CAD. (That seemed like an investment basic, but aren't you glad it worked out right?)

Looking for Arbitrage in Foreign Currency Trading

Arbitrage is the investment strategy of trading multiple currencies with the intention of profiting from any differences in the exchange rates. For example, we will trade USD, CAD and ARP. We will sell 5 USD and in return get 6.8295 CAD. After this we will sell our 6.8295 and get 14.725 Argentinean pesos. Finally when we sell our pesos and buy US dollars we get 5.00 again. While this example did not yield an arbitrage for us, it is easy to see how it works. If your investment timing is right and you catch volatility between the various pairs, arbitrage has the potential to be very profitable